The gift of education can be part of your loved ones for the rest of their lives, and this is a worthy legacy. There is a tax-efficient way to accumulate the resources they will need, and we will explain it in this post.
529 College Savings Plans
The commonly embraced solution is the 529 college savings plan. These plans have a basic structure that is similar to the Roth individual retirement account. You make contributions into the account after taxes have been paid on the income, and the assets grow in a tax-free manner.
When assets are withdrawn by the beneficiary to pay for college, the distributions are not subject to further taxation. The assets can be used to pay for tuition, books, fees, room and board, and certain supplies, including computers.
Flexibility
After you establish the account, you have the ability to take withdrawals for any reason if you choose to do so. You would have to pay taxes on the earnings, and there would be a 10 percent penalty.
One of the nice things about these accounts is the fact that you can change the beneficiary. For example, let’s say that one of your grandchildren does not use all the money in the account that you establish for them. Under these circumstances, you can make another grandchild the beneficiary of the account.
K-12 Education
Traditionally, these accounts were strictly college saving accounts, but this restriction was loosened recently. A provision that was contained within the Tax Cuts and Jobs Act that was passed at the end of 2017 changed the playing field.
Assets in these accounts can now be used to pay for approved K-12 educational expenses, but there is a $10,000 annual limit per beneficiary.
State Income Tax Deduction
In Connecticut, you can deduct the contributions when you file state tax returns, but there is a $5,000 limit per taxpayer.
Aggregate Contribution Limit
There is a maximum aggregate contribution limit, and Connecticut has one of the lower ones in the country. At the time of this writing, the limit is $300,000.
Estate and Gift Tax Efficiency
We have a federal estate tax in the United States that carries a hefty 40 percent maximum rate. That’s the bad news, but the good news is that it is only applied on the portion of an estate that exceeds $12.92 million in value.
This is called the credit or exclusion, and we should point out the fact that it is going down to $5 million adjusted for inflation at the end of 2025 if there are no legislative changes in the meantime.
There is also a gift tax, and the two taxes are unified. If you are exposed to federal transfer taxes, you could gain some tax efficiency by contributing to 529 savings plans.
There is a $17,000 per year, per person gift tax exemption. If you are married, you and your spouse could combine your respective exclusions and contribute up to $34,000 into unlimited 529 plans annually tax-free.
Since we have separate state estate and gift taxes in Connecticut, the contributions will reduce your liability on that level as well.
Attend a Complimentary Seminar!
Since you are on this site, you must be looking for information about estate planning and elder law topics. We invite you to explore of all the written materials that we have here, and if you would like to take your knowledge to another level, attend one of our upcoming seminars.
The events are offered on a complimentary basis, but we ask the register in advance so you can reserve your spot. You can see the dates and obtain registration information if you visit our Estate Planning Seminars page.
Mr. McCann is licensed to practice before the courts of the State of Connecticut. He is a member of the American Academy of Estate Planning Attorneys.
Mr. McCann provides to his clients, trust and estate planning, and trust and estate administration services. Formerly, Mr. McCann was an adjunct professor of economics in the State of Connecticut Community College system, and a Commissioner of the Town of Simsbury Zoning Board of Appeals.